Will Student Loan Forgiveness Help The Economy? Now Or Later?

Key Takeaways

• Student loan forgiveness does nothing to make inflation spike at this moment.
• People already had those payments on pause, so loan forgiveness won’t suddenly increase demand or disposable income.
• Changes to the IBR program would have long-term benefits for many student loan borrowers.

On August 24, a little more than two weeks ago, the Biden administration announced a partial student loan forgiveness program. For some, it went too far. For others, it didn’t go far enough.

Love it or hate it, the net result on the immediate economy at large is likely to be minimal, though for some individual student loan borrowers, even the truncated forgiveness could be life-changing.

Student Loan Forgiveness News

Under the new program, those who carry federal student loans will receive $10,000 in forgiveness, and those who received a Pell grant while in college will receive $20,000 in forgiveness. These loan forgiveness programs are only available to borrowers if they meet the current income guidelines.

Those who are still carrying a balance after the above forgiveness policy has been applied can also take advantage of a new rule that caps income-based repayment (IBR) at 5% of total discretionary income, which is down from the prior cap of 10%.

As a part of this plan, the Biden administration also extended the student loan moratorium through December 31, 2022. The president has clearly stated he intends this to be the final extension of the moratorium, which began under the Trump administration in March 2020. That means borrowers will need to start paying again in January 2023.

Lowering IBR Payments to 5% of Discretionary Income

Changes to the IBR program would have long-term benefits for many student loan borrowers – particularly those who make less than 225% of the federal poverty line (FPL). That’s because there would be a new formula to determine discretionary income. This new formula would determine discretionary income as anything after the 225% FPL threshold.

If you make 225% of the FPL or less, your monthly payments would be $0. If you make more than that, your payments would be capped at 5% of your discretionary income rather than the pre-pandemic cap of 10%.

Whatever the amount of your monthly payments, this program would eliminate unpaid monthly interest as long as you’re making payments on time; this means your loan balance cannot grow as long as you continue to pay your loan installments, even if the amount due is $0. The mounting interest charges that have plagued so many borrowers would also be severely curtailed as loan balances of $12,000 or less will be forgiven after ten years rather than the previously standing twenty-year term.

Currently, the IBR reduction portion of the loan forgiveness program is only a proposal. First, it needs to be posted to the Federal Register. Then, it will be open for public comment for 30 days. After that, ED will review public comments and draw up the final rule. Depending on when the process is completed, some version of this proposal could be in effect as soon as July 2023.

Does Canceling Student Loans Help the Economy?

That all depends on whose economy you’re talking about. Nearly 90% of forgiveness will go to individuals making $75,000 or less. For these households, having a few hundred extra dollars a month beyond the moratorium can make a meaningful difference in long-term financial opportunities. Borrowers may be able to:

• Pay off consumer debt at a faster rate.
• Save for educational opportunities for their children.
• Establish businesses.
• Save money for a down payment on a home.
• Invest in their tax-advantaged retirement accounts.

For personal economies, yes, student loan forgiveness is helpful.

The larger economy is likely to see slight returns, if any, in the immediate future. There’s not going to be an influx of new cash injected into the economy all at once, as these payments have already been paused for more than two years.

But there is the potential for the larger economy to experience modest long-term gains, as citizens who are currently economically disadvantaged have a bit more money to pursue their own personal financial stability and growth. For this set, we created a guide for how to invest their $10,000 worth of student loan forgiveness.

The only people who might have cause for concern are those invested in student loan asset-backed securities. However, the fact that this policy covers only a small portion of America’s $1.75 trillion in student loan debt – rather than a full forgiveness program – probably has these investors releasing a massive sigh of relief.

Does Canceling Student Loans Affect Inflation?

There are lots of reasons countries across the world are experiencing inflation right now. Forgiving federal student loan debt is not one of them.

What’s causing inflation?

Inflation has been caused by heavy demand, supply chain problems created by the pandemic, and various geopolitical conflicts, most notably Ukraine. Not enough goods are being manufactured and shipped to meet demand. That makes the cost of everything go up.

In this instance, it was not inherently caused by average consumers having more money, which has been a chief cause for inflation historically. While it is true that households received modest stimulus payments throughout the pandemic, and that many had their student loan payments on pause (freeing up some hundreds of dollars a month), this happened against a backdrop of large-scale unemployment where the average household’s income was extremely stunted. Since more people have been reporting back to work, pay has not gone up enough to keep pace with higher prices for essential goods.

Inflation has been aggravated in the U.S. in large part by corporations taking advantage of inflationary concerns by raising prices on necessities disproportionate to the monetary resources available to the average consumer. They’ve done all this while raking in record-breaking profits. At the same time, these corporations have not raised labor costs at a commensurate rate.

One of the myriad of desired results of the Federal Reserve raising interest rates is that it makes the U.S. dollar stronger, which actually decreases the cost and increases the competitiveness of imports and foreign goods. If goods from American companies are too inflated to be affordable for average consumers, comparatively cheaper imports can help them access more affordable necessities. One of the hopes is that this will drive prices from American companies down if they want to stay competitive.

Student loan forgiveness isn’t likely to affect short-term inflation

Student loan forgiveness does nothing to make inflation spike at this moment. People already have had those extra hundreds of dollars per month in their pocket for over two years, so loan forgiveness won’t suddenly increase demand or disposable income. It simply makes permanent what has been happening already.

Those owing more than $10,000 (or $20,000 if they were Pell grant recipients) will have to start making payments again in January. As far as inflation is concerned, that could be a good thing as they’d have less ‘discretionary’ income to push up demand because more of it would be going towards their federal student loan payments. But because current demand is determined more by supply chain issues and artificial price increases by American corporations, the resumption of payments is unlikely to move the needle towards lower inflation either.

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